Financial Reporting – Financial Statement Analysis
January 7, 2010 Leave a comment
Financial Statement Analysis
Who is interested in analysing a financial statement?
- Students who didn’t realise that they had signed up for CSwBM and wanted to do CS
- Employees, unions
- Community representatives
- Investment analysis
Basically lots of people.
- Shareholder wants to see whether to keep their investment in the company
- Long term lenders want to see if the company will make their scheduled payments
- Short term lenders want to see if the short term debts will get paid off
They are a quick way of assessing the financial health of a business, and when comparing two businesses they eliminate differences in scale.
- Profitability: Give insight into how successful the business is at creating profit
- Efficiency: How efficient the business is at using resources
- Liquidity: Ability to meet liabilities when due
- Financial Gearing: Degree of risk and how the business is funded
- Investment: Returns and performance
Examples from earlier revisited
- Shareholder wants to see whether to keep their investment in the company — Look at profitability, investment and gearing ratios
- Long term lenders want to see if the company will make their scheduled payments — Profitability and gearing ratios
- Short term lenders want to see if the short term debts will get paid off — Liquidity ratios
Return on shareholder’s funds:
[Profit after tax ÷ (Share capital + reserves)] x 100
Compares amount of profit available to the owners with the owners investment in the business. High is good.
Return on capital employed:
[Operating profit ÷ (share capital + reserves + long term liabilities)] x 100
The relationship between OP and long term capital.
Operating profit margin:
(operating profit ÷ sales revenue) x 100
A good measure of operational performance. Can vary a lot between business types. Supermarkets have low OP margins. Jewellers have high.
Gross profit margin:
(gross profit ÷ sales revenue) x 100
This is a measure of profitability in buying and selling goods
Company A has £350 revenue and £255 cost of sales. Their gross profit margin is [(350 – 255) ÷ 350] x 100 = 27%
Average inventories turnover period:
(Average inventories held ÷ cost of sales) x 365
The average length of time inventories are held. Businesses prefer this to be short.
Average settlement period for trade receivables:
(Trade receivables ÷ Credit sales) x 365
How long it takes debtors to repay. Shorter is preferred.
Average settlement period for trade payables:
(Trade payables ÷ credit purchases) x 365
How long it takes the business to repay credit purchases. Try to keep it low.
Sales revenue to capital employed: (asset turnover ratio)
Sales revenue ÷ (share capital + reserves + non current liabilities)
How effectively assets are being used to generate revenues. High indicated higher productivity. Too high may be overtrading and non sustainable.
Sales revenue per employee:
Sales revenue ÷ Employees
High indicates greater staff efficiency.
A company makes £475 in sales and £65 in trade receivables. What is the average settlement period for trade receivables?
(65 ÷ 475) x 365 = 50 days
Return on capital employed
Operating Profit x Sales Revenue
- Influenced by profitability and efficiency
Current assets ÷ Current liabilities
Good to be higher than 1, as assets can cover liabilities. Manufacturing tends to have a high one, supermarkets have a low one.
Acid test ratio:
Current assets (but not inventories) ÷ Current Liabilities
Excludes inventories because they cannot be turned into cash quickly.
Cash generated from operations to maturing obligations:
Cash generated from operations ÷ Current liabilities
Indication of the ability of the business to meet obligations. High is better.